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Lawsuit filed over recent Internet sales tax bill

7/9/2010

By Marianne GoodlandTHE COLORADO STATESMAN

The Direct Marketing Association has filed suit against the state of Colorado in U.S. District Court to overturn the so-called Internet sales tax bill, House Bill 10-1193, which was passed during the 2010 legislative session. The lawsuit, filed June 30, names Roxy Huber, executive director of the Department of Revenue, as defendant; a response by the state is expected by July 23, according to the Attorney General’s office.

The DMA is the nation’s largest trade association; its members market products directly to consumers via mail or phone order or the Internet. The DMA chose to become the lawsuit’s plaintiff, rather than a Colorado business, so that “no one business has to feel the brunt of any recourse from the Department of Revenue.”

The lawsuit claims HB 1193 is unconstitutional for five reasons: it imposes “discriminatory treatment on out-of-state retailers lacking any physical presence in Colorado, tramples the privacy rights of Colorado and non-Colorado residents, may having a “chilling” effect on the exercise of free speech by consumers of or vendors of certain products with “expressive content,” exposes to security risks confidential information for consumers and their purchases; and deprives retailers, without due process or compensation, the value of their proprietary customer lists and the investments made to protect those lists.

The chief sponsor of HB 1193, Rep. Jack Pommer, D-Boulder, told The Colorado Statesman he finds the DMA’s claims hypocritical and that they contradict everything the DMA is doing at a federal level regarding Internet privacy.

As originally introduced, HB 1193 attempted to copy bills passed in New York and North Carolina in 2008 and 2009, respectively. And those bills were based on a 1992 decision, Quill v. North Dakota, in which the U.S. Supreme Court opined that in order for a state to collect sales and use taxes on an out-of-state retailer, that retailer had to have a substantial physical presence, or “nexus,” within the state. In Quill, the Supreme Court overturned a lower court decision that said computer software that allowed customers to place orders was sufficient to establish that presence. In the era in which Quill was decided, online commerce via the Internet had not yet taken hold. The Quill case applied to mail-order businesses, but since the growth of the Internet Quill has been interpreted as applying to online retail sales.

The New York and North Carolina laws have both maintained that the physical presence was established by online retailers such as Amazon.com and Overstock.com through their affiliates: state residents who advertised the retailers on residents’ personal Web sites. It is believed that Amazon.com, for example, may derive as much as 40 percent of its business from affiliate referrals.

But as a result of the passage of those laws, Amazon fired its North Carolina affiliates; in New York it filed suit against the state but to date the courts have sided with the state. In New York, the online giant is collecting the sales tax while the legal cases wind their way through the system.

Colorado initially attempted to take that same approach. In the original version of HB 1193, the bill used the nexus of affiliates in order to require online retailers to collect and remit sales taxes. But Colorado affiliates, fearing that Amazon and others would do to them what they did in New York and North Carolina, amended the bill to require online retailers to inform their customers of the sales taxes owed to the state. If the retailer refused to collect the sales tax or inform the customer, the law would require the retailer to provide the Department of Revenue with the customer names and the amount of the purchase subject to state sales taxes.

The passage of HB 1193, and its subsequent signing by Gov. Bill Ritter, was not enough to assuage Amazon.com; despite the amended bill removing all references to affiliates, Amazon fired all of its Colorado affiliates on March 8, indicating they refused to be blackmailed into collecting the sales tax through burdensome regulations

Colorado is no longer alone in its approach to collecting Internet sales taxes in this manner. Members of the California assembly recently introduced a bill to tax Internet sales that is based on Colorado’s law; Tennessee also had introduced legislation in its 2010 session to adopt a law based on the Colorado model but the bill died when the Tennessee Legislature adjourned June 10.

The DMA lawsuit takes particular aim at Colorado for what it claims is unconstitutional violations of privacy and free speech. The lawsuit claims that business and organizations that use direct marketing methods and sell retail products or services are “closely associated with particular ideas, issues, opinions and beliefs. By purchasing from an online retailer a consumer may reveal information regarding the “expressive content of products obtained,” and the state has no interest that justifies interfering with the free speech rights of out-of-state retailers and consumers, both in and out of Colorado. The state could achieve its goals through other means, the lawsuit states.

Regarding the issue of privacy, the lawsuit states that the privacy interests of Colorado consumers, “with respect to purchasing information that reveals protected personal matters outweigh any interest the State of Colorado has in obtaining such purchasing information from out-of-state retailers.”

The lawsuit also claims the law violates due process for retailers: required disclosures of customer lists of Colorado purchasers to the Department of Revenue “compromises the value of the Customer List and deprives the disclosing retailer of its protected property right in the list, without due process of law. Customer lists are valuable and proprietary trade secrets, in which retailers made a substantial investment. The lawsuit also claims that in taking the customer list, the state is taking retailer private property for public use without compensating the retailer for that property.

The lawsuit also raised concerns about possible security risks through unintentional disclosure of customer information at the Department of Revenue. “The Department has no clear obligation under Colorado law to protect such Customer Lists from disclosure, and no obligation to provide the same level of data security for such information as the retailer provides.” The lawsuit also alleges that the Dept. of Revenue “has a history of failing to ensure the security of confidential data against risks of unauthorized disclosure,” although the lawsuit fails to cite even a single incident where this has happen.

Linda Wooley, executive vice president for government affairs at the DMA told The Statesman that the association does not argue whether the sales tax is owed — it is. Nor is the issue the collection of sales tax, she said; it’s the reporting requirements to which the DMA objects.

In some cases, Wooley said, it doesn’t matter whether the retailer reports exactly what is purchased. If a consumer purchases from a retailer with a descriptive name, such as the Teeny Bikini Photo Company, a consumer might not want that information disclosed.

“We concede the tax is due. The question is how the state gets it from residents. Imposing the burden on Internet retailers is not the right way to go, nor is reporting the purchases,” Wooley said.

On June 7, the DMA announced it had sent comments to House Representatives Rick Boucher (D-VA) and Cliff Stearns (R-FL) regarding draft legislation on Internet privacy, which deals with collection and disclosure of online and offline customer information. DMA expressed its concerns regarding the changes the bill would cause, and in a June 4 comment said the draft bill would fundamentally change the “prevailing framework for the transfer of data to most third parties by requiring entities [i.e. online retailers] to obtain express affirmative consent from their customers for the collection of personal information.

The DMA also said that an opt-in requirement would mark a “sea change from existing practices and law, which have long recognized that consumers expect first parties to collect at least some information.”

“Like tax reporting?” asked Pommer.

The federal bill also includes a definition of “sensitive information” that the DMA said was too vague and that such information should be restricted to that which is truly sensitive. “For years, marketers have employed market segmentation (by using information that the bill includes under the proposed definition of “sensitive information”) to provide beneficial information to individuals in a manner that has not been shown to cause harm,” the DMA statement said. “We are concerned that imposing an opt-in regime on the use of such information would negatively impact the ability of marketers to provide such tailored offerings, which in turn would be a disservice to consumers who find value in such marketing techniques.”

Pommer pointed out that in the lawsuit against the state, the DMA argues that knowing a person bought something from a particular store lets someone infer something about the buyer’s beliefs. However, in these comments the DMA argues that things such as a person’s language, which might tend to identify someone from a particular race or ethnic group, is not truly “sensitive.”

Pommer said the DMA’s objections to the federal bill argues that customers shouldn’t have control of their personal information when using an online retailer, that they shouldn’t have to “opt-in” to have the data collected.

“The DMA has done much to say that consumers have no right to privacy and they have the right to collect data about customers. For example, an online retailer can put a cookie on a computer to track where the customer goes next, and then can put all that information together,” Pommer explained.

Pommer pointed out that the DMA fought “like hell” against the no-call lists and for the right to send junk mail. “It’s horribly hypocritical of them to as champions of consumer privacy, when they’re dedicated to wiping out consumer privacy both online and offline.”

Pommer also was annoyed by the lawsuit’s allegations regarding security breaches at the Department of Revenue. The department handles a lot of confidential info without problems, Pommer said, and pointed out that among the top ten security breaches most have been from private companies. “They say DOR has a history of [security breaches] but they don’t list even one case,” he noted.

With regard to the takings issue, Pommer questioned just what value a retailer would lose. Marketers make a lot of money on reselling information and believe what they collect is valuable. The state has no intention of using that information to sell anything – just to find out who owes taxes, he said.

For one state legislator, the DMA lawsuit has re-opened only recently-closed wounds from the 2010 General Assembly, which saw a bitter and lengthy fight over HB 1193 and 11 other bills that repealed sales and use taxes or income tax exemptions.

“We have said from the beginning that this proposal jeopardizes consumer privacy and gives the government a frightening amount of access to information about personal purchases and services,” Stephens said in a statement issued earlier this month. “The bottom line is it’s none of the government’s business what someone wants to buy online.”

Stephens told The Statesman that the issue of collecting sales tax for Internet purchases was decided by the U.S. Supreme Court in 1992 through the Quill decision, which she said set the stage for the matter to be settled at the federal level.

She understands that the Colorado brick-and-mortar businesses feel that online retailers have an unfair advantage, and said there has to be a way to resolve the problem. Stephens points to legislation pending in Congress and activity at the National Conference of State Legislatures as well as interest in the Streamlined Sales Tax project.

The Streamlined Sales Tax Governing Board was started by the National Governors Association in 2000 as a multi-state effort to simplify and align sales tax policies.

According to the group’s Web site, 20 states are full members, that is, they are in compliance with the Streamlined Sales and Use Tax Agreement through laws, rules, regulations, and policies. Three more states are associate members, which means the laws and rules for streamlined sales tax have not yet gone into effect; a fourth, Georgia, is expected to join the group after that state’s governor in May signed into law a streamlined sales tax bill.

As of April 2009, 41 states and the District of Columbia had approved an interstate agreement that establishes uniform sales tax rules and definitions.

Colorado is not part of that, yet. Stephens said the state would probably be the very last one to join, in part because of issues with home rule cities that would make streamlining sales tax policy difficult. That’s borne out by the SSTBG Web site, which shows that Colorado is the only state in the country that collects a sales tax and that is not participating in the project in any way.

“I view [HB 1193] as a crack in the door,” Stephens said. “You do have to collect to be fair with brick-and-mortar stores, but we’re dealing with the Internet…I don’t want the state or federal government getting info on what I purchase. It’s not their business.”

Stephens also pointed out that in North Carolina, where Amazon.com has filed a lawsuit regarding that state’s legislation, the American Civil Liberties Union of North Carolina has sided with Amazon. She said that if the ACLU of North Carolina cared about privacy so should the ACLU of Colorado.

In April, the ACLU of North Carolina filed suit in U.S. District Court for the Western District of Washington against the state of North Carolina on the privacy issues and on behalf of six anonymous North Carolina residents. In a June 23 statement, Aden Fine, staff attorney with the ACLU Speech, Privacy and Technology Project, said the constitution “does not permit government agencies to conduct such sweeping collections of our personal and private information.” According to the ACLU suit, the North Carolina Department of Revenue has already issued a request to Amazon for purchase records dating back to August 2003 as part of a tax audit of Amazon. The online retailer complied partially with the department’s request; it submitted product codes that revealed the exact items purchased but withheld individually identifiable user information that could be linked back to those purchases.

The ACLU statement said it had no problem with the department’s authority to collect taxes, but the state did not need to know what its citizens purchased.